The Armed Services Board of Contract Appeals (ASBCA) issued a precedential decision involving issues critical to the concept of an "expressly unallowable" costs under the Cost Accounting Standards (CAS) and Federal Acquisition Regulation (FAR) that strictly limit the Government's attempts at expansive determinations. Raytheon Co., ASBCA Nos. 57576 et al. (June 26, 2015).1

Definition of an "Expressly Unallowable" Cost

The ASBCA reaffirmed that the definition of an "expressly unallowable" cost under the CAS and the FAR is narrow and discrete, holding that: an "expressly unallowable" cost "by the plain terms of the definition, must be an item of cost or a type of cost that is specifically named and stated as unallowable by law, regulation, or contract."2 The ASBCA further held that such costs must be identified as unallowable in "direct and unmistakable terms."3 Applying this narrow definition, the ASBCA found that certain bonus and incentive compensation costs were not expressly unallowableunder FAR 31.205-1 (public relations and advertising costs), 31.205-22 (lobbying and political activity costs), and 31.205-27 (organization costs) because such costs are not "specifically named and stated as unallowable" under these cost principles.  Where a cost is not expressly unallowable, there can be no noncompliance with CAS 405, nor can there be penalties pursuant to FAR 42.709.

Regarding express unallowability under FAR 31.205-22, which makes unallowable costs "associated with" certain lobbying and political activity, the ASBCA found that neither "bonus and incentive compensation" nor "compensation" cost "is specifically named and stated as unallowable under this cost principle, nor are such costs identified as unallowable in any direct or unmistakable terms."4Similarly, under FAR 31.205-27, which makes unallowable costs "in connection with" certain organization activities, the ASBCA found that neither "bonus and incentive compensation" nor "compensation" cost "is specifically named and stated as unallowable under this regulation, nor are these costs otherwise identified in any direct or unmistakable terms."5 In both instances, the government argued that the broad phrases "associated with" and "in connection with" were sufficient to render bonus and incentive compensation expressly unallowable.

Under FAR 31.205-1, the ASBCA held that although the cost principle states that portions of "salaries" and "fringe benefits" are unallowable, bonus and incentive compensation costs are neither salary nor fringe benefits.  The ASBCA observed that "salary" and "bonus" are identified under the compensation cost principle, FAR 31.205-6(p), as "different types of compensation," and further, bonus costs do not fall within FAR 31.205-6(m)'s definition of "fringe benefits."6 

Because such costs were not expressly unallowable, the ASBCA found that the there was no violation of CAS 405's requirement that expressly unallowable costs "be identified and excluded from any billing, claim, or proposal," nor was the contractor subject to any penalty under FAR 42.709-1 for the inclusion of expressly unallowable costs in an indirect cost proposal.  With this decision rejecting the government's improper assertion of express unallowability under CAS 405 and related claim for penalties under FAR 42.709-1, the ASBCA greatly reduced the quantum of the government's claim for unallowable costs.  The ASBCA did hold, however, that bonus and incentive compensation costs are expressly unallowable as "pay of directors, officers and employees" under FAR 31.205-47, because under the limited circumstances of the underlying statute and administrative history of the implementing regulation "pay" incorporates such costs.7  And, the ASBCA held that the Total Shareholder return element of Raytheon's Long Term Performance Plan was expressly unallowable under FAR 31.205-6(i).

Principle of Retroactive Disallowance and Other Defenses

To the extent the ASBCA found the government had otherwise proven entitlement to unallowable costs, the ASBCA left open for further fact finding whether the government's claim to such costs is barred under the retroactive disallowance principle established in Litton Systems, Inc. v. United States, 449 F.2d 392 (Ct. Cl. 1971).  Under the retroactive disallowance principle, where the government has consistently approved of or acquiesced in the charging of costs, it is barred from disallowing such costs prior to the issuance of an authoritative notice that such costs are no longer considered allowable.  Here, the ASBCA found that it has "applied the retroactive disallowance principle to bar recovery of government claims," citing Lockheed Martin Western Development Laboratories, ASBCA No. 51452, 02-1 BCA ¶ 31,083, but "its application is largely fact-dependent."8The ASBCA concluded that material factual disputes, including "whether or not the government, with knowledge, consistently approved" the subject costs, prevented resolution on summary judgment.  The ASBCA's continued recognition of this affirmative defense has the potential to limit the government's ability to assert claims retroactively for costs after approving the charging of such contract costs. 

Additionally, the ASBCA reserved for consideration whether fixed price contracts should be included in the cost impact calculation under a noncompliance with CAS 405, and the particular methodology for calculating the cost impact of bonus and incentive compensation as CAS noncompliance.

This case is a follow-on to Raytheon Co., ASBCA Nos. 57576, 57679, 13 BCA ¶ 35,209, where the ASBCA held that the Statute of Limitations barred portions of the government's clam.  The authors of this Advisory represented Raytheon in these matters